Practice Questions Before The Final Fall 2014

Practice Questions
12/12/14
Please, note these are a few example questions, and not a sufficient study
material for the test. To prepare adequately for the final exam, please review
the slides, worksheets from class, and practice problems at the end of the
chapters from the book.
1. Which of the following statements best describes the likely impact that an
abandonment option will have on a projects expected cash flow and risk?
a.
b.
c.
d.
e.
No impact on expected cash flow, but risk will increase.

Expected cash flow increases and risk decreases.
Expected cash flow increases and risk increases.
Expected cash flow decreases and risk decreases.
Expected cash flow decreases and risk increases.
2. Whalen Maritime Research Inc. regularly takes real options into account when
evaluating its proposed projects. Specifically, Whalen considers the option to
abandon a project whenever it turns out to be unsuccessful (the abandonment
option). In addition, it usually evaluates whether it makes sense to invest in a
project today or whether to wait to collect more information (the investment timing
option). Assume the proposed projects can be abandoned at any time without
penalty. Which of the following statements is CORRECT?
a. The abandonment option tends to reduce a projects NPV.
b. The abandonment option tends to reduce a projects risk.
c. If there are important first-mover advantages, this tends to increase the value of
waiting a year to collect more information before proceeding with a proposed
project.
d. A project can either have an abandonment option or an investment timing
option, but never both.
e. Investment timing options always increase the value of a project.
3. Diplomat.com is considering a project that has an up-front cost of $3 million and
produces an expected cash flow of $500,000 at the end of each of the next five years.
The projects cost of capital is 10%.
Based on this information what is the projects net present value?
a. -$ 875,203
b. -$ 506,498
c. $ 54,307
d. -$1,104,607
e. $ 105,999
4. Morgan Entertainment has a levered beta of 1.20. The firm's capital structure consists
of 40% debt and 60% equity and it has a corporate tax rate of 40%. What is
Morgan's unlevered beta?
a.
b.
c.
d.
e.
0.7534
0.7811
0.8043
0.8249
0.8571
5. Blumberg Inc. has an unlevered beta of 1.10. The firm currently has no debt, but is
considering changing its capital structure to be 40% debt and 60% equity. Its
corporate tax rate is 40%, rRF = 5% and the market risk premium is 4%. What is
Blumberg's cost of equity?
a.
b.
c.
d.
e.
10.56%
10.76%
10.96%
11.16%
11.36%
6. Which of the following statements is CORRECT?

a. As a rule, the optimal capital structure is found by determining the debt-equity
mix that maximizes expected EPS.
b. The optimal capital structure simultaneously maximizes EPS and minimizes
the WACC.
c. The optimal capital structure minimizes the cost of equity, which is a
necessary condition for maximizing the stock price.
d. The optimal capital structure simultaneously minimizes the cost of debt, the
cost of equity, and the WACC.
e. The optimal capital structure simultaneously maximizes stock price and
minimizes the WACC.
7. The firms target capital structure is consistent with which of the following?
a.
b.
c.
d.
e.
Maximum earnings per share (EPS).

Minimum cost of debt (rd).
Highest bond rating.
Minimum cost of equity (rs).
Minimum weighted average cost of capital (WACC).
8. The Altman Co. has a debt ratio of 33.33%, and it needs to raise $100,000 to expand.
Management feels that an optimal debt ratio would be 16.67%. Sales are
currently $750,000, and the total assets turnover is 7.5. How should the
expansion be financed to achieve the desired debt ratio?
a.
b.
c.
d.
e.
100% equity
100% debt
20% debt, 80% equity
9. Simon Software Co. is trying to estimate its optimal capital structure. Right now,
Simon has a capital structure that consists of 20% debt and 80% equity. (Its D/E
ratio is 0.25.) The risk-free rate is 6% and the market risk premium is 5%.
Currently the companys cost of equity is 12% and its tax rate is 40%. What
would be Simons estimated cost of equity if it were to change its capital
structure to 50% debt and 50% equity?
a.
b.
c.
d.
e.
14.35%
30.00%
14.72%
15.60%
13.64%
(The following information applies to the next four problems.)

Stewart Inc. has $4,000,000 in total assets. The companys current capital structure consists
of 25% debt and 75% common equity. Currently, the companys before-tax cost of debt is
8%. The risk-free rate is 5% and the market risk premium is also 5%. At the firms current
capital structure, the companys beta is 1.15 and its cost of common equity is 10.75%.
Stewarts operating income (EBIT) is $300,000, its interest expense is $80,000, and its tax
rate is 40%. The company has 80,000 outstanding shares of common stock. The companys
net income is currently $132,000, and its earnings per share (EPS) is $1.65. The company
pays out all of its earnings as dividends (EPS = DPS), and hence its growth rate is zero.
Thus, its stock price is simply EPS/r s. It follows that the companys stock price is currently
$15.3488 ($1.65/0.1075).
10. What is the companys WACC?
a. 6.29%
b. 8.86%
c. 9.26%
d. 10.06%
e. 10.70%
11. What is the companys unlevered beta?

a.
b.
c.
d.
e.
0.4107
0.9583
1.0000
1.0147
1.3800
12. Howard Contracting recently completed a 3-for-1 stock split. Prior to the split, its stock
price was $150 per share. The firm's total market value was unchanged by the split.
What was the price of the companys stock following the stock split?
a.
b.
c.
d.
e.
$ 50.00
$ 60.00
$ 90.00
$120.00
$150.00
13. Ronaldo Inc. has a capital budget of $1,000,000, but it wants to maintain a target capital
structure of 60% debt and 40% equity. The company forecasts this years net income
to be $600,000. If the company follows a residual dividend policy, what will be its
dividend payout ratio?
a.
b.
c.
d.
e.
16.67%
20.00%
25.00%
33.33%
35.00%

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Practice Questions

No impact on expected cash flow, but risk will increase.

6. Which of the following statements is CORRECT?

Maximum earnings per share (EPS).

(The following information applies to the next four problems.)

11. What is the companys unlevered beta?

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